Year-End Portfolio Checkup: 5 Tax-Smart Tips
Now is a good time to review your investment portfolio and your overall financial plans to ensure you’re saving as much as you can and working to reduce your tax bill. If you wait until after the holidays to reassess your finances, you could miss out on opportunities that disappear at year end.
Here are five end-of-year tax-smart portfolio tips to consider implementing right now:
1. Maximize your retirement savings
A tax tip you may already know: Contributions to tax-deferred retirement accounts—such as a 401(k)—reduce your taxable income and provide tax-deferred growth until retirement.1 The end of the year is a good time to re-evaluate your overall savings, do a portfolio checkup, and determine if you can bump up what you’re putting away for retirement.
You can also make lump-sum contributions from an annual bonus to give your savings a boost. And remember, if your employer offers matching contributions, don’t leave free money on the table. It’s a good idea to contribute enough to meet your employer’s full match and take advantage of those additional funds.
If you’re currently in a lower tax bracket, and you’re likely to be in a higher tax bracket when you retire (a lot of younger people fall into this category), you could benefit from making contributions to a Roth IRA or Roth 401(k). Though contributions to Roth accounts are made with after-tax dollars, that money can grow tax-free. And when you retire, you won’t have to pay taxes on the withdrawals.2
If you are self-employed or own a business, you can contribute to a tax-deferred retirement account, such as a SEP-IRA, a SIMPLE IRA, or an individual 401(k). These contributions will lower your taxable income and could help you stay under the phase-out limitations for the 20% deduction on pass-through income.3
2. Consider a Health Savings Account (HSA)
If your employer offers an HSA—and you qualify to contribute to one—this can be a smart way to set aside money for qualified medical expenses.4 HSAs offer a triple tax advantage: You pay no federal taxes on your contributions, no federal taxes on investment earnings, and no taxes on withdrawals as long as the money is used for qualified medical expenses.5
If you are fortunate enough not to have many medical expenses, are 65 or over, and have money left over in your HSA during retirement, you can use that money to pay for living expenses—the only caveat being you’ll have to pay taxes on the withdrawals when they’re not for qualified medical expenses.
3. Give to a favorite charity
As with other aspects of your finances, it’s important for charitable giving to be part of a broader financial plan, and it’s worth looking into when doing a year-end portfolio review.
One way to take full advantage of the tax benefits of charitable giving is to concentrate your giving into a high-tax year—maximizing your itemized deductions in that year and taking the standard deduction the next.6 Giving appreciated investments (like stocks) in this manner is a great way to maximize your charitable giving deduction, and a donor-advised fund (DAF) could be used to facilitate that gift. DAFs allow you to make a contribution of cash or appreciated investments held for more than one year, receive a current-year tax deduction, and avoid paying capital gains tax on the sale of assets contributed.
If you’re age 70½ or older, you could also donate up to $100,000 directly to a charity from your IRA using a qualified charitable distribution (QCD). A QCD allows you to take money directly from your IRA and give it to a qualified charity without having to recognize that withdrawal as income on your tax return. In addition, if you’re subject to required minimum distributions (RMDs), a QCD can be used to cover all or a portion of your annual RMD.
4. Gift assets to your loved ones
Each year, you’re allowed to give up to $15,000 to any number of people without having to pay a gift tax. Using this gifting strategy can allow you to transfer a large amount of wealth to your loved ones tax-free and without eating into your gift and estate tax exemption. Those gifts can be used for any number of financial goals, including funding a grandchild’s 529 college savings plan or helping a loved one make a down payment on a new house.
5. Rebalance your portfolio in a tax-smart way
The end of the year is also a good time to take a look at your portfolio and make sure it’s aligned to your goals and risk tolerance. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. This can leave you exposed to unintended risk if the market environment should suddenly change. That’s where rebalancing your portfolio comes in—and it can be an especially important task for people nearing or in retirement who might be more sensitive to market volatility.
Rebalancing involves selling positions that have exceeded your target allocation and moving the proceeds to positions that have become underrepresented. Each time you sell a position, a taxable event occurs.
With a bit of planning, you can help reduce the tax impact of rebalancing by using a strategy called tax-loss harvesting. Investors have a tendency to avoid selling anything at a loss, but there can be a significant tax benefit to selling a losing position if you have capital gains to offset. Those losses can be used to reduce your capital gains all the way to zero, and if you have more losses than gains, you can offset up to $3,000 of your ordinary income each year. Tax-loss harvesting can also serve as a motivation to sell underperforming investments or to re-diversify overly concentrated stock positions.
The bottom line
As you’re taking stock of the year past and looking forward to the year ahead, review your portfolio. You may be able to make some adjustments in order to save more for your goals and pay less on taxes.
1For 2021, the maximum employee 401(k) contribution is $19,500. If you’re age 50 or older, you are allowed to contribute an additional $6,500 in catch-up contributions, for a total of $26,000.
2For Roth accounts, you must be over the age of 59½ and have held the account for five years before withdrawals of income are tax free.
3The 20% deduction (IRC 199A) is available to owners of pass-through entities, such as sole proprietors, partnerships, and S-corporations. There are numerous limitations and rules related to this deduction, so be sure to meet with a tax professional well before year end to go over your specific situation.
4In 2021, the contribution limit for HSAs is $3,600 for self-only health insurance coverage and $7,200 for family coverage. People age 55 or older may contribute an additional $1,000 in either scenario.
5HSA contributions are not deductible in several states, including California and New Jersey. Check with your tax advisor for specific tax advice. State taxes on investment earnings may vary. See IRS Publication 502 for a list of qualified expenses.
6The standard deduction for 2021 is $12,550 for single filers and married couples filing separately, $18,800 for single heads of household, and $25,100 for married couples filing jointly.
What you can do next
Read more about tax-smart approaches to investing or talk to a Schwab Financial Consultant at your local branch.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Investing involves risk including loss of principal.
Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a nonretirement account, taxable events can be created that may affect your tax liability.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner, or Investment Manager.
A donor’s ability to claim itemized deductions is subject to a variety of limitations depending on the donor’s specific tax situation. Consult your tax advisor for more information.